No abstract
The VAR methodology of Campbell and Shiller () is employed under four different assumptions regarding equilibrium expected returns to assess the efficiency of the UK stock market. In our first model, equilibrium expected (real) returns are assumed to be constant, while in the second model, excess returns are assumed to be constant. The next two models assume that equilibrium returns depend upon a time-varying risk premium which varies with the conditional expectation of the return variance (i.e. the CAPM). Our results yield evidence of short-termism, even when the key assumption of a time-invariant discount rate is relaxed.We employ the VAR methodology pioneered by Campbell and Shiller (, , ) to test the efficiency of the UK stock market. The evidence presented here complements that obtained using variance ratio tests (for an overview see Shiller ()) and direct tests of the rational valuation formula (i.e. that stock prices equal the discounted present value of expected future dividends) using cross-section data (e.g. Miles ()).Bulkley and Tonks () applied Shiller-type variance bounds tests to annual UK time-series data. Assuming constant equilibrium returns, they found that the variance bound was strongly violated, and proffer an explanation based on the strong-form\weak-form rational expectations distinction. In this paper, we consider an alternative possibility ; that equilibrium returns are non-constant, and that existing models of time-varying equilibrium returns provide sufficient variation in discount rates so that prices are not excessively volatile.The VAR approach has several potential advantages over alternative test procedures. Within a single framework we can test for the predictability of oneperiod returns (e.g. Clare et al. (), MacDonald and Power (), Keim and Stambaugh ()) and multi-period returns (Fama and French a, b), and also perform tests based on stock prices using the rational valuation formula (RVF)."Bulkley and Tonks conduct their analysis assuming real (detrended) stock prices and dividends are stationary processes (an assumption borne out by their DF statistics). However, the extra data since ,# together with revisions to the original series, mean that this assumption is no longer empirically tenable. The VAR methodology takes explicit account of the non-stationarity in the data, as well as allowing tests of the efficient markets hypothesis (EMH) under a wide variety of assumptions about the determinants of equilibrium returns.Finally, the large number of metrics (marginal probabilities, descriptive statistics, and graphs) afforded to us by the VAR methodology allows one to make an informed judgement on the degree to which the model is in conformity " The RVF states that the current price of a stock equals the expected discounted sum of future dividend payments.# is the end of Bulkley and Tonks's data period.[ ]$ Because we have end-of period observations, whereas Campbell and Shiller (, ) used opening prices, our time su...
Recent debate on the reform of the international financial architecture has highlighted the potentially important role of the official sector in crisis management. We examine how such public intervention in sovereign debt crises affects efficiency, ex ante and ex post. Our results shed light on the scale of capital inflows in such a regime, and we establish conditions under which this leads to an improvement in debtor country welfare. The efficacy of measures such as officially sanctioned stays on creditor litigation depend critically on the quality of public sector surveillance and the size of the costs of sovereign debt crises. * Andrew Haldane, Adrian Penalver, Paul Tucker and an anonymous referee for helpful comments and encouragement. We thank seminar participants at the International Finance Summer Camp in Santiago, the London School of Economics, the University of Newcastle upon Tyne, the Bank of England and the Bank of Japan for comments on an earlier version of the paper. The usual caveat applies. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England. †
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